New federal rules that might have encouraged private equity firms to snap up troubled banks could wind up keeping those buyers in their seats.
The Federal Insurance Deposit Corporation board on Wednesday imposed tough new restrictions on private equity firms seeking to buy failed institutions, although they eased more onerous proposals in hopes of luring them to the table.
Facing a dearth of traditional bank buyers, the F.D.I.C. board tried to strike a balance between the need for fresh capital to shore up the banking system, and worries that private equity buyers might engage in aggressive practices that could put its deposit insurance fund at risk.
So far, regulators have allowed only a few groups of private equity firms to take over failed banks, including IndyMac Bank of California and BankUnited of Florida, with assurances that experienced bankers would run the operations.
Private equity firms said the new rules would make them less likely to buy a failed institution on their own. However, a few special exemptions are intended to encourage them to team up with a bank partner or a large group of private investors — strategies often considered last resorts because they must give up control and profits.
“This is going to increase the flow of capital into the community and midsize banking market because there is some certainty about what the rules are, but we may not see some of the larger deals,” said Donald B. Marron, the former head of PaineWebber who now runs the private equity firm Lightyear Capital.
The rules, which were approved by a vote of 4 to 1, would require private equity-controlled banks to pour enough capital into a failed bank so that it has a cushion of at least 10 percent of its assets for three years. While the industry lobbied hard to reduce that from a 15 percent level originally proposed by the F.D.I.C., it is still twice the minimum level that traditional banks would be required to hold.
The F.D.I.C. also dropped a requirement that private equity firms supply additional capital in the event of a severe downturn, a rule that was vehemently opposed by the industry as impractical. But regulators remained adamant in demanding that buyout firms not sell an acquired bank for at least three years, and imposed restrictions barring the acquired bank from lending to companies affiliated with the private equity buyer.
The agency also inserted a clause that would exempt private equity firms from complying with the higher capital standards if they joined forces with a traditional bank buyer, hoping to encourage such alliances.
Federal officials said the new rules applied only to future deals, and agreed to review the impact of the new regulations in six months.
Sheila C. Bair, the F.D.I.C.’s chairwoman, and three other directors of the five-member panel voted in favor of the changes, saying that they struck a compromise between competing policy objectives. John D. Bowman, the head of the Office of Thrift Supervision, cast the lone dissenting vote, saying there was a lack of evidence that the rules would protect the insurance fund.
“I am not a fan, or proponent, of private equity, but it is hard to know whether the restrictions are required,” Mr. Bowman said during Wednesday’s board meeting.
Still, regulators are increasingly concerned about industry’s ability to handle a coming wave of bank failures. Many strong traditional banks are busy digesting acquisitions they made last fall, while weaker institutions have their hands full with growing losses.
The F.D.I.C., meanwhile, has been saddled with tens of billions of dollars of troubled assets and has seen the industry’s once-flush deposit insurance fund become severely depleted. The fund had about $13 billion at the end of the first quarter, down from about $52.8 billion a year earlier. New figures will be available on Thursday when the F.D.I.C. releases its second-quarter report. So far, there have been 81 failures this year, and the pace of new ones is quickening.
The agency received more than 60 comments from private equity firms, law firms and consumer advocacy groups. Some critics feared that private equity buyers might be more prone to gamble on riskier loans in order to bolster their returns or use the banks they controlled to finance their operations. They also expressed concern that private equity buyers would quickly unload their bank investments if they did not turn a quick profit, further destabilizing the industry.
The new private equity rules are only one part of the agency’s strategy to handle the coming wave of bank failures. Regulators have also been trying to lure traditional bank buyers with lucrative loss-sharing deals, where the government agrees to shoulder the bulk of the losses on a failed bank’s riskiest loans in exchange for the acquirer’s selling off those assets.
They have also been testing a program to that would provide financing to encourage private investors to buy troubled loans from failed institutions, which might bid up asset prices.
And F.D.I.C. officials recently proposed what amounts to a melding of the two strategies. Regulators have said they might carve up failed banks into “good” and “bad” pieces, encouraging healthy banks to snap up the “good” assets with a loss-sharing agreement while leaving the most troubled assets for vulture buyers.